Why Banks May Be Happy for Their Small Slice of Subprime Auto Market

Banks and credit unions are small players in the burgeoning market for risky auto loans, and that may prove to be good news.

A key economic report published Wednesday showed that traditional lenders have a vastly lower exposure to subprime auto debt than auto finance companies.

About 6% of outstanding auto loans at banks and credit unions have credit scores below 620, compared with 33% for auto finance companies, including the lending arms of major car dealers. Overall, about three-quarters of all subprime auto loans were originated by nonbank financing companies, according to the report.

The data, published by the Federal Reserve Bank of New York, illustrates the comparatively small exposure that banks have to the subprime auto market, amid growing concerns about an asset bubble. That's important because delinquency rates are on the rise – and regulators have warned about the looming potential for losses.

"The vast majority of subprime auto loans are originated by auto finance companies," economists said in a blog post accompanying its quarterly report on household debt.

Banks and credit unions, however, originate about half of all auto loans in the market.

The report comes as a number of lenders have begun pulling back from the subprime market. Santander Consumer Holdings USA – the subprime auto lender owned by the Spanish banking giant Banco Santander – has scaled back on lending to borrowers with FICO scores below 600.

A number of regional banks – including Fifth Third Bancorp – have pulled back on auto loans across the credit spectrum.

"Someone is going to get hurt," JPMorgan Chase CEO Jamie Dimon said in discussing loosening auto loan standards during an investor conference this summer. JPMorgan has "very little" subprime auto debt, he said.

The New York Fed report provides additional cause for concern about credit quality, showing that subprime delinquencies are on the rise.

The 90-day delinquency rate for subprime auto loans was 2% in the third quarter, versus 1.9% a year earlier and 1.4% in the third quarter of 2012. Over the same period, delinquency rates for borrowers with higher credit scores were relatively flat.

Delinquencies among auto finance companies have worsened by a full percentage point over the past year, while they have improved slightly at banks and credit unions, according to the report.

In total, about 3.6% of auto loan balances were 90 days late in their regular payments.

"It's worth noting that a majority of the auto loans are still performing well – it's the subprime auto loans that heavily influence the delinquency rates," the economists said.

Meanwhile, the market for auto lending has continued to boom, with originations expected to have a peak year in 2016. During the third quarter, auto originations were $150 million, roughly in line with a year earlier. Total auto loan balances were $1.14 trillion, or 9% higher than a year earlier.

Other types of household debt are also rising. Student loan balances rose 5% during the third quarter, to $1.28 trillion. Mortgage and credit card balances also increased, while home equity revolving accounts decreased.

The 90-day delinquency rate for student loans fell slightly, to 10.9% from 11.5.

The report is based on lender classifications from Equifax and includes data from roughly 44 million consumers.

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